Jenny Ruth: Masthead must pay up to snare 100pc of Vertex

Masthead is under extra pressure to lift its $1.90 a share takeover offer for plastic packaging company Vertex.

Vertex announced on Wednesday it would report a higher profit for the year ended March than the forecast it gave to Grant Samuel for an independent appraisal of the takeover offer.

Shareholders haven't exactly flocked to accept the Masthead offer.

Masthead is required to report acceptances of its offer in steps of 1 per cent of Vertex's share capital.

Vertex chairman Tony Frankham says: "No such report has been received so it can be assumed that only minimal acceptances have been received by Masthead."

It may be that shareholders are waiting to see how the battle unfolds before making a decision - and Masthead's offer doesn't close until May 10, so they have plenty of time.

But if the offer was as attractive as Masthead maintains, I would've expected at least some acceptances.

The offer has been on the table since March 1.

Personally, I think since Masthead was prepared to pay Christchurch businessman George Gould $2.05 a share last September for its initial 19.9 per cent stake, it shouldn't get away with only $1.90.

That would seem to be against the spirit, although not the letter, of the Takeovers Code.

Masthead argues that in hindsight it paid Gould too much.

But will it have to pay as much as the Grant Samuel valuation of between $2.14 and $2.39?

My guess is probably not, especially since an alternative "mystery bidder", believed to have been Visy, decided to opt out.

Of the four analysts who cover the stock, two agree that this valuation is too much of a stretch for the company, but the others say they can get to the bottom end of the range.

Dwane Clark, at First NZ Capital, raised his discounted cash flow (DCF) valuation from $1.90 to $2 after Wednesday's announcement and says that if you exclude the costs of Vertex being a public company, that would take his valuation to $2.05.

Adding a premium for control, he is comfortable with the bottom of Grant Samuel's range.

Clark is probably the most bullish of the analysts but Selwyn Blinkhorne, at ABN Amro, whose DCF valuation before Wednesday's profit upgrade was $1.76, says adding a premium for control and excluding the public company costs also makes him comfortable with the bottom end of the range.

Goldman Sachs JB Were, which was lead manager of the share issue when Vertex floated in August 2003, had a DCF valuation of $1.74 before the profit upgrade.

John Cairns, at Forsyth Barr, who hasn't changed his November DCF valuation of $1.72, probably takes the most gloomy view.

The Grant Samuel range "is a very full price when you look at the track record and the nature of the business", Cairns says.

Nobody disputes that Vertex is in a difficult industry.

As Blinkhorne says, "Most of its products are pretty basic commodity products which they sell to major companies who have pricing power and they don't."

It is also facing spiralling raw material costs, with most plastics made from oil-based resin, although the high New Zealand dollar is somewhat offsetting this pressure.

Just how much high oil prices are hurting the industry was seen this week in the United States-based Bemis, which makes plastic packaging material for food and medical supplies.

It reported a first-quarter profit about 25 per cent lower than analysts had expected.

Then there's the company's track record. While the company's prospectus forecast earnings before interest and tax (EBIT) for the year ending March 2004 of $11.2 million, it announced a downgrade just over nine weeks after listing and eventually reported $8.96 million in EBIT.

Even this week's upgrade puts EBIT for the year ended March at between $10.5 million and $10.6 million, a 7 per cent to 8 per cent increase on last year, and still below that prospectus forecast.

Masthead adviser Steve Greenwood, of Cameron & Co, takes issue with Grant Samuel opting to value Vertex on an earnings multiple basis, or capitalisation of earnings, and then comparing it with other similar companies, rather than a DCF valuation.

"You don't dismiss the most widely used valuation technique, because its got stable earnings," Greenwood says.

He also struggles with the treatment of the premium for control in Grant Samuel's valuation.

It doesn't say what premium it has used but does say the valuation contains a premium.

It talks about premiums typically in the range of 20 per cent to 35 per cent. Vertex shares were trading at $1.60 immediately before Masthead launched its bid and the volume-weighted average over the previous 60 days was $1.58.

The Grant Samuel valuation is 33.8 per cent to 49.4 per cent higher than $1.60 and 35.4 per cent to 51.5 per cent higher than $1.58.

Greenwood also takes issue with Grant Samuel's choice of companies to compare with Vertex.

In New Zealand it chose Skellmax.

The two companies have often been linked since they listed at the same time but Skellmax's vacuum-pumps and rubber-goods manufacturing business is quite different from Vertex's packaging business, Greenwood argues.

The other companies Grant Samuel used are all bigger companies based overseas.

Australia's Amcor, for example, has a $A6.1 billion ($6.5 million) market capitalisation compared with Vertex's $60.6 million.

But then there aren't any other listed plastic packaging companies in New Zealand for comparisons.

Michael Lorimer at Grant Samuel says he didn't have sufficiently robust forecasts for a DCF valuation. Because the company has reasonably stable earnings, "a DCF will come up with no different answer to a capitalisation. It wasn't worth doing".

He says changing one small assumption, such as raw material costs, can lead to widely differing results using the DCF method, which he describes as "a lovely little academic tool".

Lorimer also says the earnings multiples he used - between 8.3 times and 9 times the latest year's EBITA - aren't very high.

Masthead does have the option of just letting its bid lapse, but I can't see it doing that.

Unless a higher bidder comes along, which doesn't look likely, it would be stuck sitting on 19.9 per cent of a company with a dysfunctional board.

I can't see it wanting to take the risks involved in Frankham's solution to that dysfunction.

He wants to put the issue of Mark Stewart, Warwick Webb and Warren Bell's board seats to a shareholders' vote.

Vertex managing director Paddy Boyle and non-executive director Sandy Maier dispute their right to sit on the board, especially since Masthead owns 51.2 per cent of Alto Plastics, a company that competes against Vertex in some areas. Masthead plans to explore a merger between Alto and Vertex if it wins this takeover battle. (The Grant Samuel valuation excludes the estimated $500,000 the company has already spent on this dispute.)

The report contained an interesting pointer to Vertex's future: Vertex and Alto are competing for one of Vertex's contracts, which is up for renewal.

If Vertex retains the business, it will be at lower margins and if it doesn't, its Naenae plant will close.

Business development is also being stymied by the board dispute, with Masthead refusing to agree to management's plans to expand into Australia with a greenfields plant making the company's Case Ready long-life meat packaging.

The Masthead camp warns it could use the $50 million it raised to fund the takeover by buying plastics companies to merge with Alto, posing a threat to Vertex.

But that would leave it sitting on 19.9 per cent of Vertex and everybody, including Frankham, expects the shares will drop if the Masthead bid fails.

So how much will Masthead have to pay? My guess is $2.05 a share - and the analysts agree that will probably be enough. The next key date is April 26, the latest Masthead can vary the terms of its offer.

Vertex Group Holdings

Managing director: Paddy Boyle.

Market capitalisation: $60.5 million.

History: Vertex was founded in 1941 and then became part of Carter Holt Harvey which sold it in a management buyout backed by Australia's Private Equity Partners in October 2000.

Products: A wide range of plastic packaging including meat and other food trays, dairy packaging, household products and industrial and agri-chemical containers.

Financial performance: The company says it will report a net profit for the year ended March of between $5.3 million and $5.4 million after all abnormal and one-off costs. That's 6 per cent to 8 per cent higher than last year and 8 per cent and 10 per cent above the forecast in the independent valuation by Grant Samuel.